Advantage Benefits Group

On the Other Hand - Weekly Economic Commentary - Principal Global Investors (back)

4/27/2011

Tug of War: Solid Fundamentals vs. Headwinds

Economic news over the last few weeks suggests the global expansion is still intact, but that risk is rising and the momentum of activity has peaked. All the risks to which markets have paid little attention over the past several weeks have become headwinds buffeting the global economy. Pulling the economy forward are solid underpinnings, strong growth in emerging markets, and ultra accommodative monetary policy. These solid fundamentals brought a self-sustaining expansion, but the risks are chipping away at the foundation. Housing and government spending are very weak, consumer spending growth stays moderate, but manufacturing is booming. The economy is no longer accelerating and momentum has peaked, but fundamentals still favor a durable expansion. China’s economy has settled onto a solid growth path for 2011. Early year reports implied significant slowing, likely just volatility around the Lunar New Year holiday. With inflation high, policy normalization will continue. Still, a slew of recent reports show sustained growth. Emerging Asia and Australia are being driven by China’s robust economy; but output is slowing as central banks hike interest rates in response to higher inflation.

Disturbances to Economies in Motion

Bad news doesn’t matter until it matters; it may be starting to. These robust fundamentals underpin the global economy and sustain the expansion; but the risks that have existed for some time are beginning to slice away at the foundation. The potential disturbances are growing. U.S. growth was slower than anticipated in the first quarter and the drags are carrying over into the second quarter. Inflation is wearing on emerging markets; Japan is taking longer to emerge from its multiple tragedies than first thought; the Euro debt crisis is still festering; oil prices keep rising; and at some point the Federal Reserve (the Fed) will start thinking about an exit strategy. We’ve had above-consensus and positive growth expectations for almost two years. We’ve believed the global economy was on solid enough footing to overcome the plethora of headwinds currently pummeling it. Events this week began to show the U.S. budget debate could be the camel’s straw that overwhelmed the fundamentals… by creating a potential policy mistake. Adding this to the Black Swans that everyone already sees makes a formidable hurdle to overcome. We believe the strong economic fundamentals will overcome the multiple headwinds in the end. But risk has risen and caution is warranted.

The U.S. Federal Budget: Doing the Math

Recent U.S. economic debates have been about virtually only one topic: the federal budget. Many believe that last year’s election shift occurred because federal spending was not only too high but seemingly growing “out of control.” Fiscal deficits are very high simply because tax revenue is much lower than current spending. The real question is the size of the shortfall and the prior level of debt. Deficit spending is nothing new, for the United States or other developed economies, but the problem has gotten worse over the last 10 years; the spending — revenue gap has been growing rapidly. Over this time, federal spending exceeded revenues by an annual average of 6.1% from 2000 to 2010 and by a truly appalling 13.8% annually over the last three years. At these levels, among the highest ever for a peacetime economy, arguments over spending plus tax and debt burdens have become huge political issues that will dominate the upcoming presidential elections. This huge rise in the “mandatory” portion of federal spending complicates the issue of controlling the budget. The atmosphere remains tense in Washington as debate resumes on next year’s budget and the need to raise the ceiling on U.S. debt. The opportunity for budget adjustments is very narrow. Since Congress can target only non-mandatory, non-defense spending, the debate is over only 19% of the budget, or $660 billion. Even if that were totally eliminated, that’s less than half of the projected 2011 deficit. At some point, the growth in entitlement spending will have to be addressed. In the meantime, there may well be cuts in things like high-speed rail and NASA projects. It’s all about funding.

Source: Principal Global Investors

News

With over six decades of combined experience, Advantage Benefits Group provides a wealth of knowledge in the employee benefits area, We bring the latest, most up-to-date information on trends in the market place. With Advantage Benefits Group, employers are assured "big picture" strategic thinking that takes into account your growth and financial goals and your need to keep employees motivated and satisfied.